How Will The Tax Cuts and Jobs Act Affect Executive Compensation?

On December 22, 2017, President Trump enacted The Tax Cuts and Jobs Act (the “Act”) which included significant changes to the tax laws regarding executive compensation.

Executive compensation is defined as financial payments and non-monetary benefits provided to high-level management, this may include but is not limited to corporate presidents, chief executive officers, chief financial officers, vice presidents, managing directors and other senior executives.

Federal securities laws require disclosure of executive compensation paid to CEOs, CFOs and certain other high-ranking executive officers of public companies. The federal securities laws also require that a company disclose the criteria used in reaching executive compensation determinations. It should be noted that the decision regarding the amount and type of compensation given to an executive officer is a business decision and is not within the jurisdiction of the SEC. The SEC’s jurisdiction extends only to disclosure to ensure that the public is provided material information to make informed investment and voting decisions.

Prior to the Act, Section 162(m) of the Internal Revenue Code of 1986 granted companies tax deductions for qualified performance-based compensation in excess of $1 million for the CEO and the three-highest compensated NEOs of the Company, CFO excluded. Performance-based compensation was subject only to the achievement of specific objectives, and not just a discretionary assessment of performance. Section 162(m) also required shareholder approval of the performance objectives through a vote that occurred every five years. Most importantly, Section 162(m) included several exemptions in which companies could avoid the limitations of 162(m).

The regulations under Section 162(m) of the Internal Revenue Code of 1986 seemed to have been working. Companies received tax benefits and shareholders were playing a role in assessing potential implications on executive compensation within the company. So how exactly does the Tax Cuts and Jobs Act change executive compensation practices?

Effective January 1, 2018, there will be no more exemptions for qualified performance-based compensation and commissions. What this means is that all compensation, which may include post-termination and post-death payments, severance, deferred compensation and payments from nonqualified plans, paid to a covered employee in excess of $1 million will be nondeductible.

Before The Tax Cuts and Jobs Act was enacted, Code Section 162(m) applied only to corporations with publicly traded equity, however, the new provision to the Act includes a transition rule. The transition rule states that the new provision of this Act will not apply to compensation payable pursuant to a written binding contract that was in effect on November 2, 2017, and where the amounts paid have not been materially modified after that date. What this essentially means is that if (1) the amounts paid are materially modified they will be subject to Code Section 162(m) and (2) if the contract was entered into or renewed after November 2, 2017, the transition rule will not apply.

What actions should companies take regarding The Tax Cuts and Jobs Act?

It is essential that companies understand that an executive who makes below the $1 million mark will be listed as an exemption on federal taxable income and an executive who receives more than $1 million will not.

Employers are encouraged to take into consideration (1) the reduction in the federal income tax rate for corporations; (2) the broader definition to which the Act expands section 162(m) to encompasses private organizations and individuals who were not recognized under the old rule; (3) the elimination of the qualified performance-based compensation; (4) and the transition rule in which the Act does not affect agreements or contracts established on or before November 2, 2017, which are not materially modified.

If you, or your institution, have any questions concerning Executive Compensation or The Tax Cuts and Jobs Act, please contact Cynthia A. Augello at caugello@cullenanddykman.com or via telephone at 516-357-3753.

Thank you to Kuljit Kaur, a law clerk with Cullen and Dykman LLP, for her assistance with this post.